June 27 (Bloomberg) -- For Ales Moravek, the ever-deeper
discounts luring buyers into his outdoor equipment store are
biting into profits. For central bank Governor Miroslav Singer,
they are adding to reasons to cut borrowing costs this week.

A deepening recession is amplifying the Czech Republic’s
traditional penchant for thrift and aversion to debt. Moravek,
who co-owns a shop in Hradec Kralove, is among Czech retailers
grappling with a shrinking market as fading consumer demand
limits room to increase prices.

“It’s incomparable,” Moravek, 47, said in an interview in
his shop 100 kilometers (62 miles) east of Prague. “We rarely
used to have sales before. Now one campaign follows another.
Discounts on boots end one day, discounts on camping equipment
start the next. This basically runs the entire season.”

Faltering demand pushed Singer, the Ceska Narodni Banka
governor, to seek a reduction in borrowing costs deeper below
the euro-area benchmark in May. As the European Central Bank
lifted and then lowered its main rate by half-percentage point
to 1 percent last year, the Czechs have held rates steady at a
record-low 0.75 percent for two years because consumers’
spending fell short of fueling inflation.

ECB Speculation

Forward-rate agreements fixing the three-month interbank
rate in three-months were quoted at 0.99 percent today, compared
with the Prague interbank offered rate, or Pribor, at 1.21
percent, according to data compiled by Bloomberg. The central
bank’s two-week repurchase rate is 0.75 percent. The yield on
two-year notes fell seven basis points to 0.9 percent at 3:59
p.m. in Prague, the lowest since at least 1997.

The ECB on June 6 kept its benchmark interest rate at 1
percent, and President Mario Draghi said “a few” policy makers
called for a cut, fueling speculation the bank may act as soon
as next month as the bloc’s debt crisis curbs growth. The
Frankfurt-based ECB said in its monthly bulletin published on
June 14 that economic growth “remains weak with heightened
uncertainty weighing on confidence and sentiment, giving rise to
increased downside risks to the economic outlook.”

Czechs shun debt as a way of boosting living standards or
to bridge more difficult periods, helping keep household debt at
about half of the euro-area level. Consumer confidence fell to
the lowest in almost 13 years in May, while retail sales
declined 4.1 percent in April, the largest decline in two years
and compared with a 5.5 percent increase in Poland.

“The Czech mentality is to try to prepare for the negative
possibilities rather than for the more optimistic ones,”
central bank board member Lubomir Lizal said in a June 11
interview in Prague. “At the time of negative news, a typical
reaction is to be even more cautious, to prepare for an even
worse situation.”

Low Indebtedness

Household debt in the Czech Republic was 58 percent of
gross disposable income and 30 percent of the country’s gross
domestic product in 2011, according to central bank data. That
compares with a gross debt-to-income ratio, a gauge of
indebtedness in relation to the ability to pay back debt, of 99
percent and a debt-to-GDP share at 65 percent in the 17-nation
euro region.

Premier Petr Necas has made slowing growth of state debt,
which at 41 percent of economic output was half of the European
Union’s average last year, a center-piece of his two-year-old
Cabinet’s program. The plan to bring the deficit below the EU’s
limit of 3 percent of gross domestic product has reduced the
state’s funding costs, with the yield on the Eurobond maturing
in 2021 falling to a record-low 2.925 percent on June 26. The
yield was 2.940 as of 4:58 p.m. in Prague.

In the Czech Republic, price bargains are one of the main
reasons for choosing grocery stores, according to a Shopping
Monitor Survey by Incoma GfK. The overall price level in a store
is the least important for Czech households among eight eastern
European countries covered in the survey, including Bosnia,
Poland, Hungary, Serbia, Slovakia, Bulgaria and Slovenia.

Disappearing Loyalty

“Compared with two or three years ago, what we are seeing
is disappearing loyalty of shoppers toward their favorite
stores,” Pavel Cabal, a researcher at Incoma, said in a June 21
interview. “The addiction to discounts has reached such a rate
that sales campaigns are more important for choosing the store
than consumers’ confidence in overall low price levels in their
favorite shops.”

The Czech central bank chief differs in his assessment of
inflation trends from policy makers in Poland, the EU’s largest
post-communist economy. The Narodowy Bank Polski was the only
bloc member to lift borrowing costs this year as inflation has
exceeded the upper end of policy makers’ target range since
January 2011. Singer is discounting a spike in inflation above
the bank’s target, fueled by a tax increase and fuel costs, and
focuses on consumers’ spending.

Tax Increases

Rate setters in Prague are assessing the impact of the
government’s tax increases on shop prices and the effects of the
euro area’s sovereign debt crisis on the economy. The central
bank’s board split three ways over monetary-policy settings at
the last meeting on May 3, with Singer and Vice-Governor
Vladimir Tomsik seeking a rate cut.

The next meeting is on June 28 and Tomsik and Singer may
not be alone anymore. Twenty of 24 economists in a Bloomberg
survey forecast a quarter-point cut in the two-week repurchase
rate to a record-low 0.5 percent.

“We are essentially stagnating because of, I believe, the
uncertainty of almost every player in this economy, and because
of fiscal measures that are necessary to keep our fiscal side
balanced,” Singer said at a conference in Prague today.
“Inflation-wise, we are not in a big trouble,” he said, adding
the only sources fueling price growth are the sales tax increase
and influences from outside the Czech Republic.

The economy contracted in the final quarter of 2011 and the
decline deepened in the first three months of this year as
weakening domestic demand outweighed rising exports after
households cut spending. Price growth has exceeded the central
bank’s 2 percent target for eight months as the government
increased the sales tax to boost budget revenue.

Deflationary Policies

“The Czech economy isn’t growing because monetary policy
is deflationary,” Lars Christensen, the chief emerging-markets
economist at Danske Bank AS said, adding the central bank had
room to ease monetary policy. “In fact, the central bank’s
policies have been deflationary and that’s why it shouldn’t be a
surprise that the Czech economy shows a growth patter similar to
Japan rather than as a catching-up economy.”

The May inflation rate dropped to 3.2 percent, the lowest
this year, from 3.5 percent in April. The rate was 0.2
percentage points lower than the central bank forecast.
Inflation relevant for monetary policy, defined as price growth
adjusted for the primary impact of changes in indirect taxes,
eased to 2 percent in May, matching the bank’s target.

Headline inflation may exceed the bank’s forecast of 1.5
percent in the second quarter of next year if the government
pushes through another set of measures aimed at boosting the
budget revenue, including an additional increase in the sales
levy and a new rate for higher earners.

Higher taxes may further depress consumer spending next
year and curtail economic growth, according to central bank
forecasts. With less disposable income, pressure on retailers
may intensify.

“Of course there is pressure on margins,” Moravek said.
“The costs are increasing, while the prices are either staying
unchanged, or rise only slightly. It’s getting much tougher to
make a living.”